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CHAPTER 9
ACCOUNTING FOR CURRENT LIABILITIES
Related Assignment Materials
Student Learning Objectives
Questions
Quick
Studies*
Exercises*
Problems*
Beyond the
Numbers
Conceptual objectives:
C1. Describe current and long-term
liabilities and their
characteristics.
1
9-1, 9-14
9-1
9-5
C2. Identify and describe known
current liabilities.
3, 4, 16, 17
9-2, 9-3,
9-14
9-2
9-6
C3. Explain how to account for
contingent liabilities.
11
9-10
9-13
9-4
Analytical objectives:
A1. Compute times interest earned
ratio and use it to analyze
liabilities.
9-11
9-14
9-5
9-1, 9-2,
9-5, 9-7,
9-9
Procedural objectives:
P1. Prepare entries to account for
short-term notes payable.
14
9-4
9-3, 9-4
9-1
9-6
P2. Compute and record employee
payroll deductions and
liabilities.
5, 6, 8, 12,
13
9-5
9-5, 9-6,
9-8, 9-9
9-2, 9-3,
9-6
9-8
P3. Compute and record employer
payroll expenses and liabilities.
5, 7, 9
9-6
9-5, 9-7,
9-8, 9-9
9-2, 9-3,
9-6
P4. Account for estimated
liabilities, including warranties
and bonuses
2, 10, 15
9-7, 9-8,
9-9, 9-13
9-10, 9-11,
9-12, 9-15,
9-18
9-4
9-1, 9-3
P5AIdentify and describe the details
of payroll reports, records, and
procedures (Appendix 9A)
4, 5, 6, 11,
12, 14
9-12
9-16, 9-17
9-6
*See additional information on next page that pertains to these quick studies, exercises and problems.
Additional Information on Related Assignment Material
The Serial Problem for Success Systems continues in this chapter. A Comprehensive Problem for Bug-
off Exterminators is also available. Problems 9-1A and 9-3A can be completed using Excel. Problems 9-
1A and 9-4A can be completed with Sage 50 Software or QuickBooks.
Connect (Available on the instructor’s course-specific website) repeats all numerical Quick Studies, all
Exercises and Problems Set A. Connect provides new numbers each time the Quick Study, Exercise or
Problem is worked. It allows instructors to monitor, promote, and assess student learning. It can be used
in practice, homework, or exam mode.
Synopsis of Chapter Revisions
• Skai Blue Media: NEW opener with new entrepreneurial assignment
• Updated payroll rates to 2014
• New explanation of Additional Medicare Tax
• Updated FUTA rate
• Clarified bonus explanation and computations
• Enhanced payroll reports and exhibits
• New evidence on payroll fraud.
Chapter Outline
Notes
I. Characteristics of Liabilities
A. Defining Liabilities
Probable future payments of assets or services that a company is
presently obligated to make as a result of past transactions or
events. Note three crucial factors:
1. Due to past transaction or event.
2. Present obligation.
3. Future payment of assets or services.
B. Classifying Liabilities
1. Current liabilities (short-term liabilities)—Obligations due
within one year or the company's operating cycle, whichever
is longer. Expected to be paid using current assets or by
creating other current liabilities.
2. Long-term liabilities—Obligations not expected to be paid
within the longer of one year or operating cycle.
C. Uncertainties in Liabilities—requires addressing three important
questions that are sometime uncertain at the time liability is
incurred:
1. Whom to pay? (Ex. A note “Payable to Bearer”)
2. When to pay? (Ex. Unearned revenues—may not know when
service will be provided to satisfy)
3. How much to pay? (Ex. Accrued expense that needed to be
estimated prior to receipt of bill)
II. Known Liabilities—Set by agreements, contracts, or laws and are
measurable. (also called definitely determinable liabilities) Examples
of these liabilities in the current classification include:
A. Accounts Payable
Amounts owed to suppliers (also called vendors) for products or
services purchased with credit.
B. Sales Taxes Payable
Amounts the retailer (seller) collects as sales taxes from customers
when sales occur, and currently owes to the government until
remitted.
C. Unearned Revenues— also known as deferred revenues,
collections in advance and prepayments.
Amounts received in advance from customers for future products
or services.
Chapter Outline
Notes
D. Short-Term Notes Payable
Written promise to pay a specified amount on a definite future
date within one year or the company’s operating cycle, whichever
is longer. Can arise from many transactions; two common
examples:
1. Creditor requires the substitution of an interest-bearing note
for an overdue account payable that does not bear interest.
(Dr Accounts Payable, Cr Notes Payable)
2. Note given to borrow money from bank.
Ex. Face value equals amount borrowed (principal) and at
maturity a larger amount is repaid. The difference between
amount borrowed and repaid is the interest. The note is
recorded at and reported at face value.
( Dr Cash, Cr Notes Payable)
In both examples above, interest is recorded as incurred. This
may be when paid with note or as end-of -period accrued
interest adjustment.
(Dr Interest Expense and Note Payable, Cr Cash) if interest is
being recorded as note is paid at maturity.
(Dr Interest Expense and Cr Interest Payable) if accrued
interest is being recorded at end-of-period adjustment.
E. Payroll Liabilities
1. Gross pay—total compensation an employee earns. (Includes
wages, salaries, commissions, bonuses). Gross pay amount is
recorded as Salaries Expense (Dr).
2. Net pay—gross less all deductions; also called take-home pay
Net pay is recorded as Salaries Payable (Cr).
3. Payroll deductions—amounts withheld from an employee’s
gross pay, either involuntary or voluntary; also called
withholdings. Each is recorded as a separate liability (Cr).
a. FICA (Federal Insurance Contributions Act) taxes can be
separated into two groups—Social Security and Medicare
taxes. FICA tax is computed as current rate multiplied by
gross wages subject to tax. For year 2014, Social Security
tax is 6.2% of the first $117,000 earned by the employee
in the calendar year and Medicare tax is 1.45% of all
wages earned by the employee. A 0.9% additional
Medicare tax is imposed on the employee for pay in
excess of $200,000 – this additional tax is not imposed on
the employer.
b. Employee Income tax payable is determined from chart
based on their gross pay, pay period, marital status and
number of withholding allowances the employee claims.
Chapter Outline
Notes
c. Voluntary deductions (charitable contributions, health
insurance premiums, union dues) result in various
payables.
(Note: All the payroll components, gross pay, each
deduction and net pay, are recorded in one journal entry.)
4 Employer Payroll Taxes—payroll taxes in addition to those
required of employees. These taxes result in expenses (Dr)
and current liabilities (Cr).
a. FICA taxes—employers must pay and amount equal to
employee contribution. The taxes are credited to the same
FICA taxes payable account used to record the amounts
withheld from the employees.
b. Unemployment taxes—(state and federal) current tax rate
multiplied by wages subject to tax. The total rate is up to
6.0% of the first $7000 earned by each employee. The
federal rate can be reduced by a credit of up to 5.4% for
taxes paid to a state program—as a result a net FUTA rate
is often only 0.6%
c. Recording Employer Payroll Taxes: additional expense
beyond Wages and Salaries Expense. Debit Payroll Tax
Expense for the Total and Credit the individual liability
accounts for the individual taxes.
F. Multi-Period Known Liabilities—known liabilities that extend
over many periods. Ex. Unearned Revenues and Notes Payable.
Classification is based upon period in which they will be satisfied.
1. Current Liability—portion that will be fulfilled in next year.
2. Long- term Liability—portion that will be fulfilled after next
year.
III. Estimated Liabilities—Known obligations of uncertain amounts that
can be reasonably estimated. Recorded as expenses (Dr) and payables
(Cr).Examples are:
A. Health and Pension Benefits—benefits beyond salaries and wages
provided by business. Appropriate proportion accrued at time of
each payroll.
B. Vacation Benefits—estimated and recorded by the employer
during the weeks the employees are working and earning the
vacation time. Appropriate proportion accrued at time of each
payroll.
C. Bonus Plans—employee bonuses must be estimated and recorded
in year-end adjusting entries.
Chapter Outline
Notes
D. Warranty Liabilities—reported to comply with the full disclosure
and matching principles. Seller reports the expected warranty
expense (Dr) and liability (Cr) in the period when revenue from
the sales of the product is reported. When warranty liabilities are
settled the liability is removed and the asset used (Ex. Parts
Inventory) is reduced.
E. Note: Estimated liabilities can also be current or long-term and
must be classified based upon when they will be satisfied.
IV. Contingent liabilities—Contingent liability is a potential liability that
depends on a future event arising from a past transaction.
A. Accounting for Contingent Liabilities—depends on likelihood that
a future event will occur and the ability to estimate the future
amount. (Accounting motivated by full-disclosure principle.)
Three categories and appropriate accounting for each:
1. Probable (likely)—record if amount can be reasonably
estimated; if cannot be estimated, disclose in footnotes to
financial statements.
2. Possible (could occur)—disclose in financial statement notes
3. Remote (unlikely)—omit (do not record or footnote).
B. (Reasonably) Possible Contingent Liabilities (category 2 above).
Examples:
1. Potential legal claims—recorded in the accounts only if
payment for damages is probable and the amount can be
reasonably estimated. If can’t be reasonably estimated or less
than probable but reasonably possible, disclose in notes.
2. Debt guarantees (of a debt owed by another company)—
require disclosure in financial statement notes if potential
liabilities are reasonably possible.
3. Other Contingencies (e.g., environmental damages, possible
tax assessments, insurance losses, and government
investigations)—require disclosure in notes if potential
liabilities are reasonably possible.
Note: Uncertainties (ex. Natural disasters) are not contingent
liabilities because they are future events not arising from past
transactions.
V. Global View—Compares U.S. GAAP to IFRS
A. Characteristics of liabilities—both systems are broadly similar in
their definitions and characteristics of current liabilities.
B. Known (determinable) liabilities—Both systems are similar for
known liabilities with the exception of tax regulatory related
liabilities since the rates and levels are different in each county.
C. Estimated liabilities—both systems require recording of estimated
expenses related to these obligations when they can reasonably
estimate the amounts.
Chapter Outline
Notes
VI. Decision Analysis—Times Interest Earned Ratio
A. Used to describe the risk of covering interest commitments when
income varies.
B. Calculated as income before interest expense and income taxes
divided by interest expense.
Appendix 9A—Payroll Reports, Records and Procedures
VII. Payroll Reports—employers are required to prepare and submit the
following reports:
A. Employer's Quarterly Federal Tax Return (IRS Form 941)
Filed within one month after the end of each calendar quarter to
report FICA and income withholding taxes owed and remitted.
B. Annual Federal Unemployment Tax Return (IRS Form 940)
Must be mailed on or before January 31 following the end of each
tax year to report an employer’s FUTA taxes.
C. Wage and Tax Statement (Form W-2)
Must be mailed on or before January 31 following the year
covered by the report; employers must give each employee an
annual report of the employee’s wages subject to FICA and federal
income taxes and the amounts of these taxes withheld.
VIII. Payroll Records
A. Payroll Register
A record for a pay period that shows the pay period dates and the
hours worked, gross pay, deductions, and net pay of each
employee; contains all the data needed to record payroll (for each
pay period) in the General Journal.
B. Payroll Check
Generally accompanied with a detachable statement of earnings
showing gross pay, deductions, and net pay.
C. Employee’s Earnings Report
A cumulative record of an employee's hours worked, gross pay,
deductions, net pay, and certain personal information about the
employee; contains the data the employer needs to prepare a Form
W-2.
Chapter Outline
Notes
IX. Payroll Procedures
A. Federal Income Tax Withholdings
Computed using a wage bracket withholding table based on gross
pay, number of personal exemptions, the employee’s tax status,
and pay period.
1. Withholding allowance—a number that is used to reduce the
amount of federal income tax withheld from an employee's
pay, and which corresponds to the personal exemptions the
employee is allowed to subtract from annual earnings in
calculating taxable income.
2. Form W-4—withholding allowance certificate form. Filed by
employee with employer to identify personal exemptions
claimed.
B. Payroll Bank Account
A separate payroll bank account used in a company with many
employees.
1. One check for total payroll is drawn on the regular bank
account or an electronic funds transfer for this amount is
executed to provide deposit for the payroll bank account.
2. Individual payroll checks are drawn on payroll account.
3. Helps with internal control and reconciling the regular bank
account.
Appendix 9B—Corporate Income Taxes
X. Income Tax Liabilities
A. Corporations (not sole proprietorships or partnerships) are subject
to income taxes and must estimate their income tax liability when
preparing financial statements. Adjusting entry: Dr Income Taxes
Expense, Cr Income Taxes Payable. Quarterly payments remove
(Dr) the liability, and credit Cash.
B. Deferred Income Tax Liabilities
Arise from temporary differences between GAAP and income tax
rules. This results in temporary differences between the tax return
and the income statement. This difference results in a deferred
income tax liability. Adjusting entry: Dr Income Taxes Expense,
Cr Deferred Income Tax Liability.
Alternate Demonstration Problem
Chapter 9
On November l, 2013, Orleaon Co. borrowed $200,000 for 90 days at 9% by
signing a note.
Required:
1. Assume that the face value of the note equals the principal of the loan.
Prepare the general journal entries to record issuing the note, accrual
of interest at the end of 2011 and the payment of the note at maturity.
Solution: Alternate Demonstration Problem
Chapter 9
Issuance:
11/1/13
Cash ................................................
200,000
Notes Payable ..........................
200,000
Year end accrual:
12/31/13
Interest Expense ............................
3,000
Interest Payable .......................
3,000
($200,000 X 9% X 60/360 = $ 3,000 accrued interest)
Maturity date:
1/30/14
Notes Payable ................................
200,000
Interest Expense ............................
1,500
Interest Payable .............................
3,000
Cash ..........................................
204,500
